Tuesday, August 28, 2007

People keep asking me what I think happens to the mortgage lead generation business in the long-anticipated chaos that is the mortgage business today. For those of you living in bubbles (how's the resale price of those holding up, btw?) the mortgage lead gen business has made plenty of hay in the last few years catering to the scramble by lenders to find high fee subprime and refinance mortgagees.

Now what? Subprime and refi were the leads that lenders paid the big money for. If subprime becomes the redheaded stepchild and casual refi can't generate quick homeowner cash like it used to, what happens to the lead generators?

This is a tough question. One the one hand, lenders need to continue to lend, that's what they do. If they have a harder time finding customers, they'll be willing to pay more for leads, benefiting the lead generators. On the other hand, generating leads in an environment where prospective customers are licking their overdrawn wounds becomes more expensive.

Couple this with the already small gross margin and the effects are difficult to predict. I assume the smaller players will exit the market or redirect their energies to lead gen categories that will prosper in this environment (lower profile subprime loans, for instance, credit repair, personal bankruptcy lawyers.) Even so, if the overall demand for online ad inventory doesn't go down, then the cost of generating a lead inevitably rises because click-through rates go down. So which rises more: the cost of generating the lead or the price that the lender is willing to pay?

I'm betting on the latter. I have several reasons to believe this, but I'm going to point, instead, to a document filed by LendingTree.com with the SEC when they were going through the process of their sale to USAI back in 2003. Look at page 31, where they show the results of various interest rate environments.

The conclusion? When interest rates were rising in Q2 2002, a difficult environment to sell mortgages in, the number of leads available for sale almost halved, just as we would have predicted. But, the percentage of these leads that were purchased by lenders grew from 50% to 83%, also as we would have predicted. The thing that threw them over the top, though? Keep in mind that a mortgage lead can be sold up to four times (no particularly compelling reason, it's just industry standard). The average number of times that each sold lead was sold rose from 2.1 to 3.1 times.

So, if you multiply these contrarily changing factors, all else being equal (ok, ok, I didn't verify that all else was equal--pari passu, you know, harumph--but I'm pretending to be an economist) the number of units sold went from 104 to 143 as the mortgage marketing environment got worse. This does not even take into account that LendingTree could charge more for each sold unit (I don't know that they did, but they could have, I suspect, without lowering the times sold per lead.)

What, you say? How could this be?

It may seem counterintuitive, but it's not. Here's the bottom line: when mortgage companies had a tough marketing environment, they outsourced their marketing to a company that specialized in marketing mortgages. That's just good business. And if it was good business then, I believe it will be good business now.

One factor I didn't take into account is the cost-per-click factor, because it wasn't at play as much in the LendingTree example. Most lead-generators don't make money on leads generated through keyword buys. When 'Refinance' costs $20/click, no landing page conversion rate results in a profitable lead (there are counter-examples, but they are special cases with structural advantages.) I can explain why lead generators buy keywords anyway, but it's a post in itself.

If mortgage-related keywords come down in price because of less competition, gross margins may rise for the lead generators.

Interesting thesis, but not accurate in my experience. I was front and center in 2002 buying leads from lendingtree, and watched my business double. 2Q02 rate increase was a blip which reversed its course shortly and led to 3 more happy years of prime refinance activity and 6+ more years if you include the 05-07 subprime and Option ARM activity. The reason LT sold more legs of its leads is that by 2Q02 there were droves of "me too" entrants to internet mortgage lending, fresh on the heels of the 4Q01 and 1Q02 refinance boom. When business gets worse, Mortgage companies will not pay more for leads. Margins thin and marketing cost per closed lian goals get very thin. We had the thick margins of subprime to support the lead buying excesses of the last few years. Mortgage Lead gen as we know it will not survive, it must change.

Thanks, Pek. Would love to get more detail from someone on your side of the fence. Lead buyers don't like to share info on close rates, etc. with lead sellers... Best data I have on comparative costs for lead gen v. other types of marketing is in new car.

Were you a broker or a lender? What was value of closed loan to you? What was close rate of leads you purchased (and actually pursued in real-ish time)?